First published in the Telegraph on 27 September 2008
For the first time in as long as I can remember, I find myself on George W. Bush’s side. It’s rather lonely. The US President has been wrong about so much during his eight years in office that it is tempting to dismiss his warnings of the impending financial apocalypse as yet more hyperbole – the boy crying wolf.
Unfortunately, this time I suspect he’s right. Treasury Secretary Hank Paulson’s bail-out is far from perfect, but without it the American and British economies face a crunch the likes of which we can hardly imagine. But how much money would you put on the likelihood of the lamest of lame-duck presidents driving the plan into law?
Not much, if the chaotic negotiations in the White House on Thursday night are anything to go by. As the $700 billion plan to prevent the world’s biggest economy slumping into the worst recession in living memory was thrown off the road by a cabal of conservative Republicans, the administration suffered an apparent nervous breakdown. Having survived the invasion of Iraq and Afghanistan and the terrorist attacks in September 2001, it took a financial crisis to bring true chaos to the heart of the free world.
Is this the way the modern economy ends? In a scene of Beckettian farce? If the bail-out does collapse, the consequences are hideous. We are in the early stages of one of the worst world slumps in living memory.
The financial system on which the economy depends has frozen. In the past few weeks, we have seen some of the world’s most venerated names in finance collapse. The US government has in effect nationalised Fannie Mae, Freddie Mac and AIG. Lehman Brothers is no more; Merrill Lynch has been eaten by Bank of America, and even Goldman Sachs has had to go cap-in-hand to Warren Buffett.
Bush was half-right: one “sucker” did go down. In the late hours of Thursday, America suffered the biggest bank failure in history, as Washington Mutual was shut down by regulators and the remnants sold to JP Morgan.
History shows that whenever there is a banking crisis, an economic slump, with all that entails – mass redundancies, falling house prices, widespread bankruptcies – invariably follows. The scale of the recession depends on the size of the banking crisis; the past year has brought the biggest systemic financial collapse since the 1930s.
We know this because economists, including Federal Reserve Chairman Ben Bernanke, have spent decades studying the causes and potential solutions for episodes such as the Great Depression. They may not have discovered a vaccine for financial panics. We make the same mistakes over and over again: borrowing too much, convincing ourselves we have minimised our financial risk, forgetting that money must be paid back and that house prices go down as well as up. But the quality of the cure has improved.
The worst thing to do now would be to impose medieval remedies. Back in the 1930s, the depression was cemented not by the Wall Street Crash of 1929, but by the hard-nosed policies of the US politicians, who allowed so many banks to fail that they set off a domino effect that took almost a decade of thrift to recover from. It was the financial equivalent of leeches and blood-letting.
In Britain, we had a comparatively benign 1930s, with not one major bank collapsing and the economy faring far better than the US. This time is different. Two of our biggest mortgage lenders have already had to be rescued. We are as vulnerable as the US – if not more so. Indeed, most likely we are already in recession, and the economy will continue shrinking until at least the latter stages of next year. Unemployment will rise by almost a million. House prices – already down by a tenth – will fall by the same margin again, probably more. The problem is that the recent lurches in financial markets could make this far worse. In short, unless the Government is prepared for some radical rescue plans, the next decade could quite easily be our very own 1930s.
Which makes it all the more shocking that, so far, the major initiatives announced by the Government and the Bank of England have been tantamount to handing a paracetamol to someone suffering a heart attack. The Bank has pumped billions of liquidity into the market and it injected more cash in yesterday. However, the lesson from the US is that at some point the Government will probably have to spend a significant chunk of taxpayers’ cash to keep the financial system – and hence the wider economy – afloat.
This may involve a similar plan to Paulson’s – a toxic waste dump for poisonous investments – or merely an injection of public money into the financial sector. It will be expensive, and the consequence, in the long run, is higher taxes or spending cuts once the economy has recovered. The Government has at least the luxury of learning some snatched lessons from America, though there is no telling how soon our own lifeboat may need to be launched.
In the meantime, the authorities must get the cost of borrowing down, or watch the housing market tumble to new lows. The Bank of England ought to have cut interest rates some months ago, but, better late than never, it should do so at the next possible opportunity. It is time to stop lecturing the patient; it is time to start applying the cure.